T3 Auditing: The working client's story

Transcription

1 T3 Auditing: The working client's story Sharlene Anderson CA Director Veritas Corp

2 AUDITING STANDARDS COMPLIANCE When auditing SMSFs it is essential that the auditor comply with the applicable auditing standards. Guidance Statement 009 provides some direction for SMSF auditors as to which standards are applicable and how in practice they should be applied. By virtue of Section 35C of the Superannuation Industry (Supervision) Act 1993 (SISA) all superannuation funds regardless of size or type must be audited on an annual basis. An SMSF audit comprises both a financial report audit and a compliance audit. The audit of the financial report enables the auditor to form an opinion as to the fair presentation of the financial report in accordance with stated accounting policies. This component of the audit is conducted in accordance with Australian Auditing Standards. The compliance audit enables the auditor to form an opinion as to the trustees compliance with specified requirements of the SISA and the SISR. This compliance audit is conducted in accordance with the Australian Standards on Assurance Engagements ASAE 3000 and ASAE So in simple terms when answering the questions which auditing standards apply to the audit of an SMSF? The answer is ALL applicable ASAs, ASAE 3000 and ASAE It is essential that all SMSF auditors apply the Auditing Standards when conducting audits to ensure not only compliance with the governing legislation but to ensure that professional indemnity coverage is provided in the unlikely event that something was to go wrong. Work papers and templates should be revised annually and updated as necessary to ensure ongoing compliance. It is also important to note that reliance on other parties, such as software providers, does not in and of itself provide a defence to auditors when found to be in breach of the Auditing Standards. It is considered the responsibility of the Auditor signing the audit report to ensure compliance, and the responsibility cannot be transferred to another party. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 2

3 AUTHORITY FOR APPLICATION OF AUDIT STANDARDS FOR SMSF AUDITS Australian Professional & Ethical Standards Board standard (APES) 210 requires members of professional bodies that adopt the standards to comply with Auditing and Assurance Standards issued by the Auditing and Assurance Standards Board (AUASB). Additionally, APES 210 requires members to comply with auditing and assurance guidance statements and other guidance publications issued by the AUASB on behalf of CPA Australia and the Institute of Chartered Accountants in Australia. This requirement has been reinforced to apply to all SMSF auditors regardless of with whom they hold their professional membership by the recent tightening of regulation of SMSF auditors. From 1 July 2013 auditors must be registered with ASIC to be an approved SMSF auditor and thereby able to be engaged to conduct SMSF audits. Section 128F(c)(ii) of the SIS Act requires approved SMSF auditors to comply with any auditing standards made by the AUASB that are applicable to the duties of an approved SMSF auditor. There is no uncertainty; approved SMSF auditors must comply with all relevant Audit and Assurance Standards for each SMSF audit conducted. CLIENT ENGAGEMENT ASA 210, 220, ASAE 3000 & 3100 Accepting a new client or deciding whether to continue with an existing client, the auditor must gain an understanding of the client and their circumstances. The process must be documented. Factors to consider would include non-compliance, fees, ethical issues and the expertise and qualifications required to perform the audit. Once the evaluation process has been undertaken the auditor needs to: a) Establish whether the preconditions for an audit are present; and b) Confirm that there is a common understanding between the auditor and management and, where appropriate, those charged with governance of the terms of the audit engagement. The engagement letter provides the means of agreeing the terms of the engagement with the client and at minimum should include the following: a) The objective and scope of the audit of the financial statements; Copyright Chartered Accountants Australia and New Zealand All rights reserved. 3

4 b) The responsibilities of the auditor; c) The responsibilities of management; d) Identification of the applicable financial reporting framework for the preparation of the financial report; and e) Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content. The engagement terms for the audit of an SMSF also need to consider the scope of the compliance component of the audit and the suitable criteria. The minimum criteria shall be the sections and regulations of the SIS Act and SIS Regulations specified in the ATO standard audit report for the relevant year. For recurring engagements, the auditor must assess whether circumstances require the terms of the engagement to be revised. Common deficiencies in SMSF audit files which represent a failure to comply with the audit standards include: a) No engagement terms in place. b) The scope of the engagement terms does not cover both the financial and compliance components of the audit c) Engagement terms in place not revised for several years. This is an issue when the scope and suitable criteria listed for the compliance component have not been updated to include additional sections and regulations added by the ATO to the standard audit report. For example, for audits of the year ended 30 June 2013 the ATO introduced 4.09A and 8.02B into the audit report. INDEPENDENCE The authority to comply with relevant independence standards is two-fold. Firstly, there is the requirement (see above) to apply Audit and Assurance Standards. ASA 102 requires the auditor to comply with relevant ethical requirements, including those pertaining to independence. The relevant ethical requirements adopted by the standard include the applicable requirements of APES 110 Code of Ethics for Professional Accountants. This requirement is repeated in both ASAE 3000 and ASAE Copyright Chartered Accountants Australia and New Zealand All rights reserved. 4

5 Secondly, section 128F(d) of the SIS Act specifically requires the auditor to comply with the auditor independence requirements prescribed by the regulations. The relevant regulation is Reg 9A.06 of the SIS Regulations, the auditor independence requirements produced by the Accounting Professional and Ethical Standards Board Limited as set out in APES 110 Code of Ethics for Professional Accountants are prescribed for all approved SMSF auditors. There is no uncertainty; approved SMSF auditors must comply with the independence requirements of APES 110. The independence standards are set out at sections 290 and 291 of APES 110. The conceptual framework requires auditors to be independent in mind AND independent in appearance. Auditors are required to: a) Identify threats to Independence; b) Evaluate the significance of identified threats; and c) Apply Safeguards, when necessary, to eliminate the threats or reduce them to an acceptable level. The auditor is required to document conclusions regarding compliance with independence requirements and where relevant to document any identified threats and the safeguards in place to reduce the threat to an acceptable level. Independence is required both during the Engagement Period and the period covered by the Financial Statements. Common deficiencies in SMSF audit files which represent a failure to comply with the audit standards The most common issue is a failure to document conclusions regarding compliance with the independence requirements and any identified threats and safeguards that have been put in place to reduce those threats to an acceptable level. Even if no threats are identified the substance of the discussion that reached that conclusion must be documented. The Threats to independence are: a) Self-interest threat the threat that a financial or other interest will inappropriately influence the Member s judgment or behaviour; for example: A member of the Assurance Team having a Direct Financial Interest in the Assurance Client. A Firm having undue dependence on total fees from a client. A member of the Assurance Team having a significant close business relationship with an Assurance Client. A Firm being concerned about the possibility of losing a significant client. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 5

6 A member of the Audit Team entering into employment negotiations with the Audit Client. A Firm entering into a Contingent Fee arrangement relating to an Assurance Engagement. A Member discovering a significant error when evaluating the results of a previous Professional Service performed by a member of the Member s Firm. b) Self-review threat the threat that a Member will not appropriately evaluate the results of a previous judgment made or service performed by the Member, or by another individual within the Member s Firm or employing organisation, on which the Member will rely when forming a judgment as part of providing a current service, for example: A Firm issuing an assurance report on the effectiveness of the operation of financial systems after designing or implementing the systems. A Firm having prepared the original data used to generate records that are the subject matter of the Assurance Engagement. A member of the Assurance Team being, or having recently been, a Director or Officer of the client. A member of the Assurance Team being, or having recently been, employed by the client in a position to exert significant influence over the subject matter of the engagement. The Firm performing a service for an Assurance Client that directly affects the subject matter information of the Assurance Engagement. c) Advocacy threat the threat that a Member will promote a client s or employer s position to the point that the Member s objectivity is compromised, for example: The Firm promoting shares in an Audit Client. A Member acting as an advocate on behalf of an Audit Client in litigation or disputes with third parties. d) Familiarity threat the threat that due to a long or close relationship with a client or employer, a Member will be too sympathetic to their interests or too accepting of their work, for example: A member of the Engagement Team having a Close or Immediate Family member who is a Director or Officer of the client. A member of the Engagement Team having a Close or Immediate Family member who is an employee of the client who is in a position to exert significant influence over the subject matter of the engagement. A Director or Officer of the client or an employee in a position to exert significant influence over the subject matter of the engagement having recently served as the Engagement Partner. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 6

7 A Member accepting gifts or preferential treatment from a client, unless the value is trivial or inconsequential. Senior personnel having a long association with the Assurance Client. e) Intimidation threat the threat that a Member will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the Member, for example: A Firm being threatened with dismissal from a client engagement. An Audit Client indicating that it will not award a planned non-assurance contract to the Firm if the Firm continues to disagree with the client s accounting treatment for a particular transaction. A Firm being threatened with litigation by the client. A Firm being pressured to reduce inappropriately the extent of work performed in order to reduce fees. A Member feeling pressured to agree with the judgment of a client employee because the employee has more expertise on the matter in question. A Member being informed by a partner of the Firm that a planned promotion will not occur unless the Member agrees with an Audit Client s inappropriate accounting treatment. The ATO 1 and the Joint Accounting Bodies Independence Guide 2 identify scenarios specifically included in APES 110 where the threats to independence cannot be safeguarded and the auditor should decline the engagement. a) Where the individual auditor has significantly prepared the accounts for the SMSF b) Where staff reporting directly to the auditor have prepared the accounts c) An auditor cannot audit their own SMSF d) Where a partner within the auditor s firm is a member/trustee of the SMSF Copyright Chartered Accountants Australia and New Zealand All rights reserved. 7

8 e) Where a relative or related party of the auditor is a member/trustee of the SMSF or where the auditor has a close personal relationship or business relationship with a member/trustee of the SMSF APES 110 provides that for audit clients that are not Public Interest Entities, such as SMSFs, the auditor may provide services of a routine or mechanical nature, so long as any self- review threat created is reduced to an acceptable level. For example, recording transactions for which the client has determined or approved appropriate account classification, posting transactions coded by the client to the general ledger, posting client-approved entries to the trial balance and preparing financial statements based on information in the trial balance. Similarly, preparation of the tax return by the auditor is acceptable if the SMSF trustees take responsibility for the returns including any significant judgments made. Where the auditor prepares calculations for current and deferred tax for the purpose of preparing accounting entries a self-review threat is created. The significance of the threat depends on the complexity of the tax law, degree of judgment necessary in applying the law and the materiality of the amounts to the financial statements. Safeguards must be applied when necessary to eliminate or reduce the threat to an acceptable level. Examples of such safeguards are using professionals who are not members of the audit team to perform the service, using a non-audit partner to review the calculations or obtaining advice on the service from an external tax professional. CHINESE WALLS Remembering that auditors are required to be independent in mind and in appearance, can one partner in a firm perform an audit where another partner is responsible for the preparation of the accounts? The Joint Accounting Bodies Independence Guide provides guidance in this area specifically in relation to audit of SMSFs. Scenario A partner within an accounting firm is responsible for the preparation of a SMSFs accounts and tax returns. Another partner within the same firm is assessing whether to accept the audit engagement of the SMSF. The response to this scenario in the Independence Guide identifies that first and foremost outsourcing the audit function would avoid any issues with independence. Where this is not done it is suggested that larger firms will normally find it easier to put appropriate safeguards in place whereas smaller firms will find this challenging. If appropriate safeguards, often referred to as Chinese Walls cannot be put in place the firm will need to decline the audit engagement and outsource the audit function. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 8

9 Independence should not be impaired where segregation of the actual roles and responsibilities for the preparation of the financial statements and the audit of the financial statements exists. But what constitutes segregation of duties? The Independence guide states: Where a firm has separate business divisions carrying out the different roles with distinctly different reporting lines to partners within those divisions, it could be possible for this arrangement to establish an appropriate safeguard and for the auditor to be able to meet their professional obligations. Typically, this would involve a business services division (or SMSF administration services division) and a separate audit division. Staff within each division would carry out the work reporting to the partner of each of those divisions. Smaller firms with two or three partners would find it difficult to put appropriate safeguards in place. Example one in Chapter 7 covers appropriate safeguards that could be put in place such that both the audit and accounting function are able to be carried out in the same firm. In that example, the appropriate safeguards would entail the client taking explicit responsibility for the financial statements and any adjustments that the firm makes. In an SMSF context it would be difficult to see how these safeguards could actually work in practice, unless the firm is able to demonstrate their assessment that the SMSF trustee had sufficient knowledge of the accounts and any changes, to truly be in a position to take responsibility for them; and that in fact the trustee did take responsibility for them. It is therefore the view of CPA Australia, Chartered Accountants Australia and New Zealand and The Institute of Public Accountants that proper segregation of duties in small firms without separate and distinct divisions will find it difficult to achieve independence when that firm both prepares and audits the SMSF financial statements. REFERRALS AND INDEPENDENCE Outsourcing SMSF audits does not guarantee independence. The Independence guide identifies the following scenarios where the outsourced auditor may have independence issues: 1. Where an auditor is a consultant, ex-partner or former employee of the referring firm. In this scenario familiarity and self-review threats may exist particularly if little time has passed since working for the firm. 2. Where an auditor is the father of a principal in a firm that has referred the audit work. In this scenario the perception of independence may be questioned as the auditor may be reluctant to qualify an audit Copyright Chartered Accountants Australia and New Zealand All rights reserved. 9

10 where a breach has occurred due to an error on the part of his son. I would also suggest that there may also be a reluctance to qualify where the breach is the fault of the client in order to maintain the relationship between the auditor s son and his client. 3. Where financial advisory services are supplied by the audit firm to the audit client. The example given is where a limited recourse borrowing arrangement has been recommended and set up by the firm. The auditor may not be independent in making an assessment of whether the arrangement is compliant. 4. Where an auditor is referred multiple SMSF audit clients by a single accounting firm. It is usual practice for an auditor to be referred a large number of SMSF audit clients by a single firm that is outsourcing the audit function. The Independence Guide notes that where a large percentage of an SMSF auditor s work comes from one referral source, dependence on that referral source and possible concerns centred on retention of the audit clients may create a threat to independence. This is despite the fact that ultimately each audit engagement is with the trustee of each SMSF. Safeguards include reducing the dependency on the external accounting practice (source of audit client referrals), external quality control reviews or external consultation on key audit judgements. The guide suggests that due to the self-interest threat and intimidation threat created in a scenario where a single referral of audit work would double the fee base of the auditor, the auditor may need to decline some or all of the audit work to eliminate or reduce the threat to an acceptable level. This principal that a referral of multiple audit clients from a single accounting firm essentially represents a single audit fee from an independence viewpoint has recently been included in APES 110. Section (formerly section before subsequent amendments was added to the standard with an effective date of 1 July 2013 and is produced below: Section 290 Independence Audit and Review Engagements When the total fees from an Audit Client represent a large proportion of the total fees of the Firm expressing the audit opinion, the dependence on that client and concern about losing the client creates a self-interest or intimidation threat. The significance of the threat will depend on factors such as: The operating structure of the Firm; Whether the Firm is well established or new; and The significance of the client qualitatively and/or quantitatively to the Firm. 3 countants%20-%20nov% pdf Copyright Chartered Accountants Australia and New Zealand All rights reserved. 10

11 The significance of the threat shall be evaluated and safeguards applied when necessary to eliminate the threat or reduce it to an Acceptable Level. Examples of such safeguards include: Reducing the dependency on the client; External quality control reviews; or Consulting a third party, such as a professional regulatory body or a Member, on key audit judgments. AUST In certain circumstances another party or Firm may refer multiple Audit Clients to a Firm. In these circumstances, when the total fees in respect of multiple Audit Clients referred from one source represent a large proportion of the total fees of the Firm expressing the audit opinions, the dependence on that source and concern about losing those clients creates a self-interest or intimidation threat. The significance of the threat shall be evaluated and safeguards applied when necessary to eliminate the threat or reduce it to an Acceptable Level. Paragraph provides examples of factors that may affect the significance of the threat and potential safeguards. This is obviously problematic for newly established or developing firms. Safeguards can and should be put in place to reduce the threat to an acceptable level as identified above and should be documented. Safeguards may include declining some or all of the audit engagements to reduce the dependency on the client or obtaining other unrelated engagements to dilute the dependency on the firm. Engaging a professional such as an unrelated approved SMSF auditor to perform regular external quality control review and consulting a third party, such as the ATO, a superannuation association or an unrelated approved SMSF auditor on key audit judgment. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 11

12 Auditing The Working Client Story Investment in Options The purchase of an option is not an overly common transaction in an SMSF and each option is likely to be unique. Consideration should be given to who the option was purchased from to ensure it is not a related party or Part 8 associate. For compliance the fund investment strategy would need to allow the purchase of options. As an auditor it will be essential to obtain a copy of the option document and review the terms for compliance issues. It is assumed in the working client case study that the option has been purchased from an unrelated party and that the investment strategy allows for this type of investment. It is expected that the terms of the option would require forfeiture of the initial $10,000 if the option is not exercised. In this scenario the option is over real property and if it was material consideration could be given to obtaining a title search to ensure that the vendor in fact had legal title to the property subject to the option. Proposed Property Development We are advised that Will intends to exercise his option and Brownstone Super will purchase the land. He then intends to develop the land into apartments with his long term friend Marty. We are advised that Will and Marty are not in business together, however they co-own a commercial property. As Brownstone Super will be providing the land for the development, Will s friend Marty (Through his SMSF) will pay Brownstone Pty Ltd for the development costs. The primary issue here is can Will and Marty enter into the proposed development without breaching any of the various SIS requirements. The first key issue is to ascertain if Marty and Will are related parties? So who or what is a related party? Section 10(1) of the SISA defines related party as: A member of the fund: Section 15B of the SISA allows for the regulations to provide that a person is to be treated, or is not to be treated as a member. For regulated superannuation funds regulation 1.03 states member means a Copyright Chartered Accountants Australia and New Zealand All rights reserved. 12

13 member of the fund and members would therefore usually be readily identifiable. However, for part 2 of the regulations (Information for certain parties) regulation 2.01 a member is taken to include a person who receives a pension from the fund or has deferred his or her entitlement to receive a benefit from the fund. It should also be noted that regulation 1.04AAA provides that for certain periods a non- member spouse is to be treated as a member when a payment split under Part V111B of the Family Law Act 1975 (Cth) is in progress. A standard employer sponsor of the fund Section 16 of the SISA defines a standard employer sponsor as an employer who has an arrangement with the trustee of the fund to make contributions. This would usually be in the case of defined benefit funds and is therefore no longer commonly encountered. If the employer contributes pursuant to an arrangement between the employer and the members then the employer is not a standard employer sponsor. Section 70A of the SISA also allows the regulator to determine in writing that a person is taken to be a standard employer sponsor of the fund. Part 8 Associates It is this third limb of the definition of related party that is the focus of most auditor attention. Part 8 Associates of fund members and standard employer sponsors are defined in the SISA by sections: 70B (Part 8 associates of individuals); 70C (Part 8 associates of companies); and 70D (Part 8 associates of partnerships). Section 70C and 70D are most relevant in determining related parties of standard employer sponsors. SMSFs very rarely have a standard employer sponsor. Accordingly, these sections will not be discussed further in this paper. Our focus will be on part 8 associates of the individual fund members defined in section 70B which is reproduced below: Part 8 associates of individuals For the purposes of this Part, each of the following is a Part 8 associate of an individual (the primary entity), whether or not the primary entity is in the capacity of trustee: (a) a relative of the primary entity; (b) if the primary entity is a member of a superannuation fund with fewer than 5 members: i. each other member of the fund; and ii. if the fund is a single member self managed superannuation fund whose trustee is a company-- each director of that company; and Copyright Chartered Accountants Australia and New Zealand All rights reserved. 13

14 iii. if the fund is a single member self managed superannuation fund whose trustees are individuals-- those individuals; (c) a partner of the primary entity or a partnership in which the primary entity is a partner; (d) if a partner of the primary entity is an individual--the spouse or a child of that individual; (e) a trustee of a trust (in the capacity of trustee of that trust), where the primary entity controls the trust; (f) a company that is sufficiently influenced by, or in which a majority voting interest is held by: i. the primary entity; or ii. another entity that is a Part 8 associate of the primary entity because of another paragraph of this section or because of another application of this paragraph; or iii. 2 or more entities covered by the preceding subparagraphs. Subsection (a) makes relatives of each fund member a Part 8 associate of the fund member. Relative is defined in section 10(1) and is described above under the heading of section 65 lending to members. The definition is quite expansive but again auditors should note it does not include cousins of members. Subsection (b) makes each other member of a SMSF a part 8 associate of the fund member as well as non-member directors or non-member trustees in the case of single member fund. For example, if an auditor is considering a related party transaction in SMSF A, and one of the members in that fund is also a member of SMSF B, all other members of SMSF B are Part 8 associates of the member of SMSF A. Subsections (c) and (d) include as part 8 associates persons or entities that the fund member is in partnership with and if the partner is an individual the spouse or child of that individual. Subsection (e) causes trustees of a trust to be Part 8 associates of the member where the member controls the trust. Section 70E (2) defines control of a trust as: When a group has a fixed entitlement to more than 50% of the capital or income of the trust; or the trustee of the trust or a majority of trustees, is accustomed or under an obligation or might reasonably be expected to act in accordance with the directions, instructions or wishes of a group; Where a group is able to remove or appoint the trustee of the trust. Group means the member acting alone, a part 8 associate of the member acting alone, the member and one or more part 8 associates acting together or 2 or more part 8 associates of the entity acting together. The first of these three tests is objective and can be determined by identifying the unit types and holdings of the group. Likewise, the third test is objective and can be determined by reference to the Trust Deed Copyright Chartered Accountants Australia and New Zealand All rights reserved. 14

15 of the trust. However, the second of the tests is more subjective. When the majority of trustees (or directors of a corporate trustee) of the trust are fund members or part 8 associates making up the group then the test is satisfied and the other trustees or a corporate trustee would be a part 8 associate of the member. The test may also be satisfied where the group do not represent the majority but one or more of the group is overbearing or has external means of persuasion to direct the other trustees. Also, for example, in the case of a trust with a corporate trustee with two directors, one a fund member and the other otherwise unrelated, if the member is the chairman and the constitution gives the chair a casting vote then that trustee company would be a Part 8 associate of the member. Finally, subsection (f) makes a company a Part 8 associate of a member where the company is sufficiently influenced, or a majority voting interest is held by the member or other Part 8 associates of the member. Sufficient influence is defined in section 70E as: (a) a company is sufficiently influenced by an entity or entities if the company, or a majority of its directors, is accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); This is a subjective test and depends on how decisions of the entity are made. In The Trustee for the R Ali Superannuation Fund and Commissioner of Taxation [2012] AATA 44 the SMSF made loans to a company, Alnaz Pty Ltd. For part of the relevant period the fund member was one of two directors and the other director was unrelated. However, the tribunal held that the company was related as the fund member controlled and directed the company and the other director was appointed to create an appearance of independence and did not have any input into managing the company. Clearly Marty is not a member of the fund or a standard employer sponsor so the remaining question is Marty a part 8 associate? The relevant section is Part 8 Associates of Individuals and the question is are Marty and Will partners by virtue of the co-ownership of the commercial property. In realty the answer is most likely yes and therefore the proposed development will be problematic and likely result in an inhouse asset. Further information would be required to absolutely determine the relationship. Investment Strategy All SMSF s are required to have and give effect to an investment strategy. An auditor should review their investment strategy and ensure that the investments are provided for with the strategy. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 15

16 Collectable and Personal Use Assets From 1 July 2016 the transition period ends and regulation 13.18AA SISR will apply to collectable and personal use assets that were acquired by the fund before 1 July Accordingly, those assets will no longer be able to be leased to or used by a related party, cannot be stored in the private residence of a related party, must have a written record of decisions relating to storage and must be insured in the name of the fund. Additionally, if the asset is sold to a related party after 1 July 2016 the value must be determined by a qualified independent valuer. A breach of the insurance requirement occurs if it is more than 7 days since the fund acquired the item and the item is not insured in the name of the fund. As the transitional arrangements ended on 1 July 2016 it is at that date than any item that was acquired before 1 July 2011 will have to be insured in the name of the fund. Regulation 13.18AA is a reportable section in the auditor contravention report and one which includes a statutory time period. The auditor contravention reporting guidelines require a breach of a statutory time period by more than 14 days to be reported. Accordingly, we would suggest that, for 2017 audits, any collectible and personal use assets such as artwork, which was acquired before 1 July 2011 and is not insured in the name of the fund by 15 July 2016, will require a contravention report to be lodged. When conducting an audit for the year ended 30 June 2016 of a fund with collectable and personal use assets acquired before 1 July 2011 the auditor should consider including details in the Management Letter to the trustees of the additional compliance considerations that apply from 1 July It should also be noted that section 129(3)(c) of the SIS Act requires the auditor to report in a contravention report any breach of a matter specified in the ACR that may have occurred, may be occurring or may occur. Accordingly, if performing an audit of an SMSF for the 2016 year that held a collectible and personal use asset before 1 July 2011, and the auditor has knowledge that the asset is not insured in the name of the fund by 15 July 2016 the auditor would be required to lodge an ACR describing the breach that may occur post 30 June A modification to the compliance conclusion in the 2016 audit report may not be required as the breach occurs subsequent to 30 June The audit the art work is not insured in the name of the SMSF and as such there is a reportable breach. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 16

17 Residential Property The residential property is leased to Monica s cousin for $850 per week. The market appraisal provided suggests that market rent is between $450 and $500 per week. The auditor will need to obtain a copy of the lease agreement, the insurance policy, supporting evidence for the value of the property and a title search to confirm ownership by the SMSF. Having already been in trouble with an ACR lodged in relation to Will s cousin living in a residential property paying below market rent we now have the almost opposite problem with Monica s cousin now paying above market rent. The first consideration is in relation to tenant and we need to determine if Monica s cousin is a relative. Relative is defined in section 10(1) of the SISA as: "relative" of an individual means the following: (a) a parent, grandparent, brother, sister, uncle, aunt, nephew, niece, lineal descendant or adopted child of the individual or of his or her spouse; (b) a spouse of the individual or of any other individual referred to in paragraph (a). Note: Subsection (5) may be relevant to determining relationships for the purposes of paragraph (a) of the definition of relative. (5) For the purposes of paragraph (a) of the definition of relative in subsection (1), if one individual is the child of another individual because of the definition of child in subsection (1), relationships traced to, from or through the individual are to be determined in the same way as if the individual were the natural child of the other individual. "child", in relation to a person, includes: (a) an adopted child, a stepchild or an ex-nuptial child of the person; and (b) (b) a child of the person's spouse; and (c) someone who is a child of the person within the meaning of the Family Law Act 1975 Note that cousin is not included in the definition of a relative. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 17

18 So the second issue is the above market rental. Section 109 of the SISA essentially requires fund investments to be made and maintained on arm s length terms. Receipt of rent in excess of market rate is arguably not a breach of the arm s length requirement of section 109 (1) of SISA. Section 109 (1) SISA is breached when the fund invests and the transaction is not on arm s length terms and the terms of the transaction are no more favourable to the other party than would be expected if the parties were at arm s length. As the terms are more favourable to the fund a breach may not have occurred. Whilst there is a school of thought which suggest that a breach of section 109 does not occur if the SMSF is not disadvantaged. However, section 109 (1A) SISA requires that having made an investment, the fund must deal with other parties on arm s length terms during the term of the investment. Therefore, it is suggested that the lease arrangement at above market rent is in breach of section 109 (1A), specifically not dealing with other parties on arm s length terms during the term of the investment. The other consideration is the potential that SMSF is in receipt of non-arm s length income. Non arm s length income received by a SMSF is taxed at the highest marginal tax rate. Non arm s length income cannot be included in exempt current pension income. The non-arm s length income rules are contained in section ITAA97. This section replaced the special income rules of section 273 ITAA36. Taxation Ruling TR2006/7 discusses special income but the ruling is also taken to be a ruling about non-arm s length income in s ITAA97 where that section expresses the same ideas as s273 ITAA97. Section ITA97 includes as non-arm s length income: 1) Income from a scheme where the parties are not dealing at arm s length and the SMSF receives more than if the parties had been dealing at arm s length 2) Private company dividends unless the amount is consistent with an arm s length dealing. 3) Income from a discretionary trust 4) Income from a fixed trust entitlement IF the entitlement was acquired under a scheme where the parties were not dealing at arm s length and the SMSF receives more than if the parties had been dealing at arm s length. Non arm s length income for an SMSF includes income derived from a scheme in which the parties were not dealing with each other at arm s length and the SMSF derives more income than if the parties had been dealing with each other at arm s length. Examples may include loans to related companies (within 5% of Total fund assets) with above market interest rates or disposal of fund assets to related parties where consideration is set above market value. However, the most common example with SMSFs is business real property leased to a related company with the amount of rent set at higher than market rate. Such arrangements may be motivated by a desire Copyright Chartered Accountants Australia and New Zealand All rights reserved. 18

19 to get money into super that is tax deductible to the related company as rent payments, especially when the members have reached concessional contributions caps. In circumstances where parties are not dealing with each other at arm s length, and the income derived by the fund is greater than might have been expected if the parties were dealing with each other at arm s length, then there is likely to be a non-arm s length income issue. It should be noted that it is not just the amount in excess of market rate that would be considered non-arm s length income but all of the rent received by the fund (see paragraph 154 of TR2006/7). That is, in this case study the non-arm s length income would be $850 per week. Cash The bank statements provided comprised an internet transaction print out and a copy of the 30 June 2016 Bank statement. The Australian Auditing Standards may not expressly require Bank Audit Certificates to be obtained but they do require the auditor to obtain sufficient appropriate audit evidence and note that evidence obtained directly by the auditor from a third party is more persuasive than evidence obtained from the client subject to audit. In a recent request for a Bank Audit Certificate from Westpac we were informed that from 1 April 2016 Westpac Group will accept audit confirmation requests only via confirmation.com. We understand the turnaround time for Bank Audit Certificates when using this medium is impressive. However, our understanding is that for Westpac accounts the auditor would have to fill out a form for each separate account the fund holds with Westpac. The auditor is required to pay a fee of $29.95 for the form lodged (one payment only would be required for Westpac notwithstanding that several forms may be sent for separate accounts). The SMSF is also charged a Bank Audit Certificate fee by the bank. It appears that the request forms are not immediately straight forward and quick to complete. It may be that a trade of will exist between efficient receipt of obtaining a Bank Audit Certificate and the additional cost and time incurred in making the request. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 19

20 In a space that already receives significant push back from trustees and administrators the auditor should not allow higher costs and time involved to affect their professional judgment as to whether a Bank Audit Certificate is required as audit evidence. If you find you have insufficient appropriate audit evidence and decide to qualify financial it is suggested that you should also consider the sufficiency of the audit evidence in relation to compliance. Accountants Exemption Repealed From 1 July 2016 the accountants exemption was repealed and accountants can no longer recommend the establishment or winding up of a self-managed superannuation fund unless they are appropriately licensed. SMSF auditors have always had to walk a fine line between giving any sort of advice to their audit clients whilst avoiding giving financial advice and adhering to the requirement to be an independent auditor. The removal of the accountants exemption presents a timely opportunity to reinforce to SMSF auditors the care that must be taken in communications to trustees, usually in the form of the Management Letter or Auditor Closing Report. Section 129 of SISA requires the auditor to report to the trustee in writing any breach of SISA that has been identified as may have occurred, may be occurring or may occur, regardless of the amount or materiality in question. Some auditors have taken the approach to offer useful suggestions to the trustee(s) about how such matters can be rectified. However, take for example a situation where a member and individual trustee of an SMSF has become a disqualified person (e.g. bankrupt) in May To avoid a breach of section 126k of SISA the member resigns as individual trustee. Now that one of the members is not a trustee the fund fails to meet the definition of an SMSF and a breach of section 17A will occur after 6 months if no action is taken. If the auditor in this example were to suggest that the member immediately rolls their benefits out of the SMSF this may be advice that the auditor would have to be properly licenced to give. Auditors should have always and continue to take extreme care in Management Letter comments. Suggestions that may constitute financial advice, such as suggesting a property is adequately insured, that the fund should sell artwork because the compliance issues are difficult or that the fund should review and update an Investment Strategy should be strategically avoided or worded with extreme caution to avoid the possibility the comments can be construed as financial advice. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 20

21 Disclaimer This paper represents the opinion of the author(s) and not necessarily those of Chartered Accountants Australia and New Zealand or its members. The contents are for general information only. They are not intended as professional advice - for that you should consult a Chartered Accountant or other suitably qualified professional. Chartered Accountants Australia and New Zealand expressly disclaims all liability for any loss or damage arising from reliance upon any information in these papers. Copyright Chartered Accountants Australia and New Zealand All rights reserved. 21